The Basics of Price Action

The Basics of Price Action

The Basics of Price Action

To use Price Action strategy as part of your overall trading strategy, it’s important for you to become familiar with price charts. As we’ve mentioned, your platform can generate these for you using any timeframe you choose.

To get started with Price Action, here are some ground rules to keep in mind:

  1. When you begin testing out a strategy, it’s best to stick to it for as long as you can. Often, investors make the mistake of hopping from one strategy to another. For instance, if you choose to use the MACD, then stick to it until you master it. This will enable you to get a sense of where this strategy will take you, particularly when considering the complexity of the elements involved. You will find that successful investors start out by mastering one strategy. Once they see that it can provide them with good returns, they can move on to try out others. If it doesn’t meet their expectations, they can try another.
  • Also, focus on higher timeframes when analyzing data. A timeframe can be a month, a week, or even a day. By the same token, you can analyze years of data. In this case, it’s always best to analyze higher timeframes. For instance, you can look at the action over a month or more. This helps to eliminate any unjustified spikes in trading, which may convince you of unreasonable trading. This is important to note as sudden events may impact investor psyche, therefore, leading to a spike in trading. This is important to bear in mind as overtrading can catch up to you. By “overtrading,” we mean placing too many trades in a short period of time. You might get sucked into this trap if you look at lower timeframes such as a week or just a couple of days.
  • Perhaps the easiest way to begin mastering Price Action is to copy successful trades. This might seem like a no-brainer, but it actually makes a lot of sense. When you copy successful trades, you can gain a sense of how to determine what to do in any given situation. As you gain experience, you will be able to set up your own strategy.

When starting out with Price Action, take a look at daily charts. Daily charts are a great way of spotting patterns. For example, you might find that certain currency pairs have a higher trading volume at certain times of the day. This may be the reflection of other markets opening and closing. Also, you may notice that certain price points trigger buying and selling. Thus, you can figure out where to get in based on these points.

So, let’s take a look at some Price Action strategies which will help you get the most out of your trades.

Broken Trendline Retest Strategy 

This strategy consists of assuming the behavior of a price will revert to the mean once the mean has been broken. This strategy plays off the fact that all prices eventually revert to their mean unless there are significant changes that can alter their mean. However, alterations in mean usually take a long time (relatively speaking) and do not happen overnight.

In this Price Action strategy, you need to plot a trendline for any currency pair. Generally speaking, the trendline should look into at least 20 time periods (usually a higher timeframe such as an hourly chart). So, you can take a look at the movements over the last 24 to 48 hours. This should provide you with enough information with regard to the overall behavior of the price itself. 

Then, you can look for points at which the actual level of the price of the currency pairing breaks trend meaning it trades above or below the actual trendline. When this occurs, you can assume the price will return back to its original trend. This is where you can bank on profits being made. In addition, you can predict with reasonable certainty that the price will eventually shift back to where you originally spotted it.

To double check your strategy, you can go back to look at similar periods in which the valuation of the currency pairing broke the trendline. In such cases, you must study to see how long it took for the currency pairing to return to trend. In some instances, it might be a question of a few hours. In other instances, it might even take days. At the end of the day, it largely depends on the prevailing market conditions. Nevertheless, previous behavior should give you a very clear indication of what to expect.

You don’t need any special indicators for this strategy to work. In fact, all you need is a price chart that contains at least hourly information. However, it is not recommended that you look at lower timeframes, such as daily data, as you could miss a great deal of information. So, a good rule of thumb is to take an hourly chart that goes back roughly 24 to 48 hours.

Resistance and Support Levels

To make the break and retest strategy functional, you need to focus on the support and resistance levels, as seen in price trends. Essentially, a support level is the lowest level that the price will touch down before rebounding back up. On the other hand, a resistance level is the highest point at which a price will hit before coming back down. 

When looking at these levels, you can ascertain the band in which a currency pair is trading. Consequently, you can determine how low a price will go and how high it will reach. Generally speaking, you can determine these points by looking at the price action for the last 24 to 48 hours. 

A good rule of thumb is to observe resistance and support levels, hitting at least three consecutive times. When you see this (the actual figure of a support or resistance level is always the exact same though it’s very close), you can assume that any divergence of these support levels will mean a reversion to mean.

Let’s assume that you are tracking the USDEUR pairing. You observe a support level of 1 and a resistance level of 1.05. This implies that the pairing will be trading in this range. During the period you are observing, you notice that the low point has hit 1, or at least very close to it. Once this point is hit, the price bounces back up to a max of 1.05. At that point, the price will come back all the way down to 1 and back up. When you notice this action for at least 3 times, you can assume that any time the price breaks through any of these points, you can assume a reversion back to mean. 

So, here is where you can implement the strategy: track the price movement over a given period. When you see the price touch down to the support or hit the resistance level, then you need to be on the lookout for the price breaking either level. You can set up your trade so that it goes through as soon as the price breaks either point. Your entry point can be above or below the break while your exit point can be once the price reverts to mean.

A word of caution: be careful using this strategy when there is a high degree of volatility, as seen in wild swings in price or trading volume. In these cases, you may have unusual price action, which may take longer than expected to revert to mean.